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Costs of ⠀刀攀ⴀ)Building Trust—Why Should We Trust One Another?

Costs of ⠀刀攀ⴀ)Building Trust—Why Should We Trust One Another?

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for sure that companies “do badly by being bad.” The major banks found this out the hard way. Prior

to 2008 many were making upwards of 20 percent return on equity. For many today it is well below 5

percent, with some not even making their cost of capital. From a shareholder perspective, they should

no longer exist.30

What are the chances, realistically, that Wall Street will wake up to Jensen’s exhortations and act

with integrity? Surely, expedience and short-term gain are coded into the DNA of the Western

financial system.

Enter blockchain technology and digital currencies. What if parties didn’t have to trust one

another, but could still act with honesty, accountability, consideration, and transparency because it

was the foundation of the technological platform of finance?

Steve Omohundro gave us a compelling example. “If somebody from Nigeria wants to buy

something that I’m selling, I’m going to be very skeptical, I’m not going to accept a credit card or a

check from Nigeria. With the new platform, I know I can trust it and I don’t have to incur the costs of

establishing trust. So it enables transactions which simply couldn’t happen otherwise.”31

So Wall Street banks don’t have to splice integrity into their DNA and behavior; the founders of

blockchains have coded it into their software protocols and deployed it across the network—enabling

a new utility for the financial services industry. The good news is that the industry can reestablish

trust and maintain it in an ongoing way.

With blockchain technology causing the costs of searching, contracting, coordinating, and creating

trust to plummet, it should be easier for firms not just to open up, but also to forge trusting

relationships with external parties. Acting in one’s self-interest serves everybody’s interests.

Cheating the system costs more than using it as designed.

This is not to say that corporate brands or for that matter acting ethically is unimportant or no

longer required. Blockchain helps ensure integrity and therefore trust in transactions between peers. It

also helps achieve transparency—a critical factor in trust. However, as author and technology

theorist David Ticoll says: “Trust and brand are about more than vouchsafing a transaction. They are

also about quality, enjoyment, safety of a device or service, cachet and coolness. In today’s COP21

world, the best brands transparently and verifiably signify outcomes that are environmentally,

socially, and economically responsible.”32

Still, through smart contracts, executives can be held accountable—they must abide by their

commitments as enforced and settled by software. Companies can program relationships with radical

transparency so everyone has a better understanding about what each party has signed up to do. And

overall, like it or not, they must conduct business in a way that is considerate of the interests of other

parties. The platform demands it.

DETERMINING CORPORATE BOUNDARIES

Overall, the boundaries that separate a company from its vendors, consultants, customers, external

peer communities, and others will become harder to define. Perhaps as important, they will constantly

change.

Firms will still exist, blockchain notwithstanding, because the mechanisms for searching,

contracting, coordinating, and establishing trust within corporate boundaries will be more cost-



effective than those in the open market, at least for many activities. The idea of the so-called free

agent nation, where individuals execute work outside the boundaries of corporations, is illusory.

Melanie Swan, who founded the Institute for Blockchain Studies, said, “What’s the right size of the

corporation for optimal transactibility? Well, it’s not a unitary thing, of people working only as

individuals or e-lancers.” To her, there will be new kinds of “flexible business entities of individuals

and groups partnering around projects.” She views the new model of the firm more like the guild, the

preindustrial associations of merchants or tradesmen who worked together in a particular town. “We

still need organizations acting as coordinating mechanisms. But the new models of team collaboration

are not yet fully clear.”33

Today we often hear that firms should focus on their core. But when considering how blockchain

technology drops transaction costs, what is core? And how do you define that when a company’s core

is constantly changing?

It seems that everyone has a different definition of what the optimal firm size should be to

maximize productivity and competitive advantage. Many firms we examined didn’t have a clear view,

seeming to choose the Bob Dylan approach to determining what’s in and what should be out (“You

don’t need a weatherman to know which way the wind blows”). Back-office processing, for example,

was described as a no-brainer, without any clear criteria as to why.

Some are more rigorous. From the core competencies view developed by Gary Hamel and C. K.

Prahalad, firms gain competitive advantage through competence mastery. Those competencies

mastered are central to the firm, while others can be acquired from outside.34 However, a firm may

have mastery over some activities that are not mission critical. Should they still be kept inside?

Strategist Michael Porter has an implicit view that competitive advantage stems from activities,

in particular from networks of reinforcing activities that are hard to replicate in their totality. It’s not

the individual parts of the business that matter, but how they are strung together and built to reinforce

one another in a unique activity system. Competitive advantage comes from the entire system of

activities; while any individual activity within the system may be copied, competitors cannot produce

the same benefit unless they manage to duplicate the entire system.35

Others argue that companies should always retain functions or capabilities that are mission

critical—those that firms must absolutely get right for survival and success. But making computers is

mission critical for computer companies; yet Dell, HP, and IBM outsource much of this activity to

electronics manufacturing services companies like Celestica, Flextronics, or Jabil. Final assembly of

vehicles is mission critical for an auto manufacturer; yet BMW and Mercedes contract with Magna to

do this activity.

Stanford Graduate School of Business professor Susan Athey argues persuasively: “There may be

some mission-critical functions, like the collection and analysis of big data, that are just too risky to

move outside corporate boundaries, even if you don’t have unique abilities in that area.”36 True, there

may be some functions like data analytics where survival depends on being uniquely good, and there

may be existential risks of partnering. Still, external resources can be deployed strategically to build

internal capability.

Our view is that the starting point for corporate boundary decisions is to understand your

industry, competitors, and opportunities for profitable growth—and use this knowledge as the basis

for developing a business strategy. From there, the blockchain opens up new opportunities for

networking that every manager and knowledge worker needs to consider at all times. Boundary



choices are not simply for senior executives, they are for anyone who cares about marshaling the best

capability for innovation and high performance. We should add—and this is no small point—that you

can’t outsource your corporate culture.

Enter the Matrix

Taking into account how blockchain technology can enable access to unique capabilities outside

corporate boundaries, firms can now define those business activities or functions that are fundamental

to competitiveness—that are both mission critical and also unique enough to ensure differentiated

value.



However, this In-Out Matrix is just a starting point for defining corporate boundaries at any given

point. What other factors should firms consider in determining what is fundamental? What extenuating

circumstances are there that might affect choices to outsource or nurture internally?



Hacking Your Future: Boundary Decisions

When making boundary choices, firms should start using the blockchain to marshal a 360-degree view

and reach consensus on what is unique and what is mission critical in their business. Let’s return to

Joe Lubin and ConsenSys, as they foreshadow the modus operandi of the blockchain-based

enterprise. Remember that ConsenSys is in its infancy, and much can go wrong to undermine its

business. We can still learn from this company’s example.

1. Are there possible partners who could do the work better? In particular, could we benefit

from harnessing new peer production communities, ideagoras, open platforms, and other

blockchain business models? The company ConsenSys is able to orchestrate extraordinary

expertise to do its work, even though many are outside its boundaries.

2. Given blockchain technology, what are the new economics of corporate boundaries—the

transaction costs of partnering, versus keeping/developing in-house? Can you develop a suite

of smart contracts whose core elements are modular and reusable? ConsenSys uses smart

contracts to reduce coordination costs.

3. What is the extent of technological interdependence versus modularity? If you can define

business components that are modular, then you can easily reconfigure them outside corporate

boundaries. ConsenSys sets standards for software development and provides access to

various software modules that its partners can build upon.

4. What are your firm’s competencies with regard to the managing of outsourced work? Can

smart contracts enhance those competencies and lower costs? From the get-go, ConsenSys

was a blockchain business. CEO Joe Lubin embraces the technology and a modified

holacracy, and we can see the seven design principles at work.

5. What are the risks of opportunism where a partner might encroach on fundamental parts of

your business, as some have suggested Foxconn may do to smart phone companies?

ConsenSys tries to mitigate this challenge by building loyalty through incentive structures

whereby its talent shares in the wealth they create.

6. Are there legal, regulatory, or political obstacles to deeper networking (and shrinking) of

the organization? Not a problem for ConsenSys yet.

7. Speed and pace of innovation are important to boundary decisions. Sometimes firms have

no choice but to partner for a strategic function because they cannot develop it in-house fast

enough. A partner arrangement can be a placeholder. Will partnering help us build an

ecosystem that will improve our competitive advantage? This is ConsenSys’s strategy: build

a network of collaborators around the Ethereum platform, grow the platform and ecosystem,

and increase the probability of success for all components.

8. Is there a danger of losing control of something fundamental—for example, a product or

network architecture? Firms must have a sense of which parts of the value chain will be key

to creating and capturing value in the future. If these are farmed out, the firm will lose. The



Ethereum platform provides a basic architecture for ConsenSys.

9. Is there a capability, like the exploitation of data assets, that must be part of the fabric of

your enterprise and all its operations? Even though you lack a unique capability, you

should view partnering as a transitional tactic to develop extraordinary internal expertise

and capacity. Blockchain technologies will introduce a new set of capacities that need to

reside in the cranium of every employee. You can’t move culture outside your boundaries.



CHAPTER 5



NEW BUSINESS MODELS:

MAKING IT RAIN ON THE BLOCKCHAIN



F



ounded a month before the market crashed in 2008, Airbnb has become a $25 billion platform,

now the world’s largest supplier of rooms as measured by market value and rooms occupied. But

the providers of rooms receive only part of the value they create. International payments go through

Western Union, which takes $10 of every transaction and big foreign exchange off the top. Settlements

take a long time. Airbnb stores and monetizes all the data. Both renters and customers alike have

concerns about privacy.

We brainstormed with blockchain expert Dino Mark Angaritis to design an Airbnb competitor on

the blockchain. We decided to call our new business bAirbnb. It would look more like a memberowned cooperative. All revenues, except for overhead, would go to its members, who would control

the platform and make decisions.

BAIRBNB VERSUS AIRBNB

bAirbnb is a distributed application (DApp), a set of smart contracts that stores data on a homelistings blockchain. The bAirbnb app has an elegant interface: owners can upload information and

pictures of their property.1 The platform maintains reputation scores of both providers and renters to

improve everyone’s business decisions.

When you want to rent, the bAirbnb software scans and filters the blockchain for all the listings

that meet your criteria (e.g., ten miles from the Eiffel Tower, two bedrooms, four-plus star ratings

only). Your user experience is identical to that in Airbnb, except that you communicate peer to peer

on the network, through encrypted and cryptographically signed messages not stored in Airbnb’s

database.2 You and the room owner are the only two people who can read these messages. You can

swap phone numbers, an exchange that Airbnb blocks to preserve future revenues. On bAirbnb you

and the owner could communicate off-chain and complete the transaction entirely off-chain, but you

are better off completing the transaction on-chain for a few reasons.

Reputation: Because the network records the transaction on the blockchain, a positive review

from each user improves your respective reputations. The risk of a negative review motivates each

party to remain honest. Remember, people with good reputations can use the same persona across

multiple DApps and benefit from continuity as a good person.

Identity Verification: Because we are not dealing with a centralized system that checks ID on our

behalf, each party needs to confirm the other party’s identity. The blockchain calls up a contract from

a “VerifyID” application, one of many contracts that bAirbnb, SUber (blockchain Uber), and other

DApps use to verify real-world identity.



Privacy Protection: VerifyID doesn’t track and store all transactions in a database. It simply

returns a TRUE or FALSE when it receives a request for verification of a public key (persona).

Different kinds of DApps can call VerifyID, but VerifyID never knows details of transactions. This

separation of identity from activity greatly improves your privacy.

Risk Reduction: Home owners currently store customer identities and financial data on their own

servers, which can be hacked and leaked, exposing owners to litigation and large liabilities. On the

blockchain, you needn’t trust a vendor with your data; there is no central database to hack and leak.

There are only individual peer-to-peer pseudonymous transactions.

Insurance: Today Airbnb offers $1 million insurance for owners and compensates them for theft

and damage. On bAirbnb, owners can get the bAirbnb insurance DApp. Renters with good reputations

like you have lower insurance rates and needn’t subsidize renters who lack caution, scrutiny of

prospects, or poor treatment of property. When you submit a booking request, bAirbnb sends your

public key (persona) to the insurance contract for a quote. The insurance DApp contacts a list of

trusted providers; fake insurers need not apply. Insurers perform their own calculations in real time

through autonomous agent software based on the inputs to the contract—such as the market value of

the owner’s house, how much the owner wants insured, owner reputation, your reputation as a renter,

and rental price. bAirbnb takes the best bid and adds it to the nightly fee the owner wants to charge.

The blockchain processes this calculation in the background; owners and renters have a comparable

user experience to that of Airbnb but a superior and more equitable value exchange.

Payment Settlement: Of course, on the blockchain, you transfer funds to the owner in seconds, not

days as with Airbnb. Owners can manage security deposits more easily with smart contracts. Some

parties use escrow accounts to release payments partially (nightly, weekly, hourly, etc.) or in full as

the parties agree. In disputes involving smart contracts, parties can call for arbitration.

Property Access Using Smart Locks (IoT device): A smart lock connected to the blockchain

knows when you have paid. When you arrive, your near-field communication-enabled smart phone

can sign a message with your public key as proof of payment, and the smart lock will open for you.

Owners need not drop keys off to you or visit the property unless they want to say hello or address

some emergency.

You and the owner have now saved most of the 15 percent Airbnb fee. Settlements are assured

and instant. There are no foreign exchange fees for international contracts. You need not worry about

stolen identity. Local governments in oppressive regimes cannot subpoena bAirbnb for all its rental

history data. This is the real sharing-of-value economy; both customers and service providers are the

winners.

GLOBAL COMPUTING: THE RISE OF DISTRIBUTED APPLICATIONS

Before we examine the other possible distributed business entities like bAirbnb, a word on how the

underlying technology enables decentralization. Until the blockchain, centralized organizations have

held concentrated computing power.

In the first decades of enterprise computing, all software applications (apps) ran on the computers

of their owners. GM, Citibank, U.S. Steel, Unilever, and the U.S. federal government owned huge

data centers that ran proprietary software. Companies rented or “time shared” computer power from

providers like the 1980s giant CompuServe to run their own applications.



As the personal computer matured, the software market specialized: some developed client apps

(the PC) and some, server apps (a host computer). With widespread adoption of the Internet,

specifically the World Wide Web, individuals and companies could use their computers to share

information—initially as text documents and later as images, videos, other multimedia content, and

eventually software apps.3 Sharing began to democratize the information landscape. But it was shortlived.

In the 1990s, a new variant of time-sharing appeared, initially called virtual private networks

(VPNs) and then cloud computing. Cloud computing enabled users and companies to store and

process their software and data in third-party data centers. New technology companies like

Salesforce.com built fortunes by harnessing the cloud model to save customers the big costs of

developing and running their own software. Cloud service providers like Amazon and IBM built

ginormous multibillion-dollar businesses. During the 2000s, social media companies like Facebook

and Google created services that ran on their own vast data centers. And to continue this trend of

centralized computing, companies like Apple moved away from the Web’s democratizing architecture

to proprietary platforms like the Apple Store where customers acquired proprietary apps, not on the

open Web but in exclusive walled gardens.

Again and again in the digital age, large companies have consolidated—created, processed, and

owned or acquired—applications on their own large systems. Centralized companies have begotten

centralized computing architectures that have, in turn, centralized technological and economic power.

Some red flags: With single points of control, companies themselves are vulnerable to

catastrophic crashes, fraud, and security breaches. If you were a customer of Target, eBay, JPMorgan

Chase, Home Depot, or Anthem, or for that matter Ashley Madison, the U.S. Office of Personnel

Management (second breach!), and even Uber, you felt the pain of hacking in 2015.4 Systems of

different parts of a company still have big challenges communicating with one another, let alone with

systems outside the firm. For us users, it means that we’ve never really had control. Others define our

services with their implicit values and goals that may conflict with ours. As we generate reams of

valuable data, others own it and are building vast fortunes—perhaps the greatest in history—while

most of us receive little benefit or compensation. Worst of all, central powers are using our data to

create mirror images of each of us and may use these to sell us stuff or to spy on us.

Along comes blockchain technology. Anyone can upload a program onto this platform and leave it

to self-execute with a strong cryptoeconomical5 guarantee that the program will continue to perform

securely as it was intended. This platform is public, not inside an organization, and it contains a

growing set of resources such as digital money to incent and reward certain behavior.

We’re moving into a new era in the digital revolution where we can program and share software

that’s distributed. Just as the blockchain protocol is distributed, a distributed application or DApp

runs across many computing devices rather than on a single server. This is because all the computing

resources that are running a blockchain constitute a computer. Blockchain developer Gavin Wood

makes this point describing the Ethereum blockchain as a platform for processing. “There is only one

Ethereum computer in the world,” he said. “It’s also multiuser—anyone who ever uses it is

automatically signed in.” Because Ethereum is distributed and built to the highest standards of

cryptosecurity, “all code, processing, and storage exists within its own encapsulated space and no

one can ever mess with that data.” He argued that critical rules are built into the computer, comparing

it to “virtual silicon.”6



As for DApps, there have been warm-up acts prior to blockchains. BitTorrent, the peer-to-peer

file-sharing app, demonstrates the power of DApps as it currently consumes over 5 percent of all

Internet traffic.7 Lovers of music, film, and other media share their files for free, with no central

server for authorities to shut down. Iconoclastic programmer Bram Cohen, who incidentally is less

than enthusiastic about bitcoin because of all the commercial activity around it, developed BitTorrent.

“The revolution will not be monetized,” he said.8

Most of us think that generating revenue and economic value through technological innovation is

positive, as long as the revolution is not monetized by the few. With blockchain technology the

possibilities for DApps are almost unlimited, because it takes DApps to a new level. If, as the song

says, “Love and marriage, love and marriage, go together like a horse and carriage,” then so do

DApps and blockchains. The company Storj is a distributed cloud storage platform and a suite of

DApps that allow users to store data securely, inexpensively, and privately. No centralized authority

has access to a user’s encrypted password. The service eliminates the high costs of centralized

storage facilities; it’s superfast; and it pays users for renting their extra disk space. It’s like Airbnb

for your computer’s spare memory space.

THE DAPP KINGS: DISTRIBUTED BUSINESS ENTITIES

How do DApps infuse greater efficiency, innovation, and responsiveness into the structure of the

firm? What new business models can we make with DApps to generate value? And if powerful

institutions are capturing the benefits of the Internet today, how can we move beyond “outsourcing”

and “business webs” to truly distributed models of innovation and value creation that can distribute

prosperity and the ownership of data and wealth? We mapped what we believe to be the four most

important innovations onto a two-by-two matrix.



The Y-axis identifies the degree to which humans participate in the model. At the left, the model

requires some human involvement. At the right, the model requires no people.

The X-axis describes the functional complexity of the model, not its technical complexity. At the

lower end are models that perform a single function. At the top are models that perform diverse

functions.

These are all components of the blockchain economy because they use blockchain technology and

often cryptocurrencies as their foundation. Smart contracts (discussed in the last chapter) are the most

basic form: they involve some complexity that requires human involvement, increasingly in the form

of multisignature agreements. As smart contracts grow in complexity and interoperate with other

contracts, they can contribute to what we call open networked enterprises (ONEs). If we combine

ONEs with autonomous agents—software that makes decisions and acts on them without human

intervention—we get what we’re calling a distributed autonomous enterprise that requires little or

no traditional management or hierarchy to generate customer value and owner wealth. And we think

that very large numbers of people, thousands or millions, might be able to collaborate in creating a

venture and sharing in the wealth it creates—distributing, rather than redistributing, wealth.

Open Networked Enterprises

At very low cost, smart contracts enable companies to craft clever, self-enforcing agreements with



previously improbable classes of new suppliers and partners. When aggregated, smart contracts can

make firms resemble networks, rendering corporate boundaries more porous and fluid.

Blockchain technology also drops Coase’s search costs and coordination costs so that companies

can disaggregate into more effective networks. An auto company could check a supplier’s

trustworthiness by just scanning the analytic services online. Soon, just type “axle” or “window

glass” into any number of industry exchanges on the blockchain and negotiate the price online.

We can extend that simple scenario to finding a replacement part, a supply chain partner, a

collaborator, or a piece of software for managing a distributed resource. Need steel from China,

rubber from Malaysia, or glass from Wichita, Kansas? No problem. Decentralized online

clearinghouses operating as DApps for each commodity will enable purchasers to contract for price,

quality, and delivery dates with a few clicks of a mouse. You’ll have a detailed searchable record of

previous transactions—not just how various companies were rated but precisely how they honored

their commitments. You can track each shipment on a virtual map that shows its precise location in

the journey. You can microschedule goods to show up just in time. No warehouse required.

AUTONOMOUS AGENTS

Imagine a piece of software that could roam the Internet with its own wallet and its own capacity to

learn and adapt, in pursuit of its goals determined by a creator, purchasing the resources it requires to

survive like computer power, all while selling services to other entities.

The term autonomous agent has many definitions.9 For our discussion, it is a device or software

system that on behalf of some creator takes information from its environment and is capable of making

independent choices. We could describe some autonomous agents as “intelligent” although they lack

general intelligence. However, they are not “just computer programs” because they can modify how

they achieve their objectives. They can sense and respond to their environment over time.10

The computer virus is the most cited example of an autonomous agent; the virus survives by

replicating itself from machine to machine without deliberate human action. Unleashing a virus on the

blockchain could be more difficult and certainly costly because it would likely have to pay the other

party to interact with it, and the network would quickly identify its public key, crash its reputation

score, or not validate its transactions.

For positive blockchain examples, consider the following. A cloud computing service rents

processing power from various sources, growing to Amazon’s size by making rental deals with other

computers that have excess capacity.11 A driverless car owned by a community, company, individual,

or perhaps itself moves around the city picking up and dropping off passengers and charging them

appropriate fees. We’re interested in agents that can do transactions, acquire resources, make

payments, or otherwise produce value on behalf of their creator.

Vitalik Buterin, who created the Ethereum blockchain, has theorized about these agents and

developed a taxonomy to describe their evolution. At one end are single-function agents like viruses

that go about working to achieve their limited goals. Next up are more intelligent and versatile agents,

say, a service that would rent servers from a specific set of providers like Amazon. A more

sophisticated agent might be able to figure out how to rent a server from any provider and then use

any search engine to locate new Web sites. An even more capable agent could upgrade its own



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